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What are hard money loans?

what is a hard money loan

Hard money loans, or bridge loans, are a type of secured short-term financing that uses real estate property as collateral. As of 2022, approximately 65.8% of Americans own a home.1 Since home repairs and renovations are costly, many homeowners use hard money loans to finance costs. 

Here, you will learn about hard money loans and how they compare to other forms of funding. 

What You Should Know About a Hard Money Loan 

The hard money loan definition is vital to know, but it’s also critical to learn how they work. Hard money lenders usually provide non-conforming loans. A non-conforming loan is essentially a loan not funded or backed by a traditional bank. Loans may be non-conforming if they cater to borrowers with credit scores lower than a bank’s minimum credit criteria or deal in funding amounts that are significantly higher than a traditional bank or lender’s loan limit. 

Loan Amounts 

The funding amount for secured loans is often heavily based on the value of the collateral the borrower offers. Typically, the higher the value of the collateral a borrower uses to secure a loan, the higher the loan amount they will receive. For hard money loans, the funding amount is typically determined by the estimated market value of the property being used as collateral. 

Interest Rates 

Interest rates for hard money loans are determined by the individual lender based on factors like the risk associated with the loan, the value of the collateral, market conditions, and the borrower’s financial standing. Rates are typically higher than loans from traditional lenders due to the increased risk. Typically, annual interest rate charges are around 10% to 18%.2

Who Do Hard Money Loans Work For?

Hard money loans work best for consumers or companies looking to profit from real estate investments. Borrowers may seek funding from a hard money loan for the following reasons: 

  • To flip a house
  • For purchasing investment property
  • For buying commercial real estate

Who Typically Invests in Hard Money Loans?

Hard money loans are typically funded by private real estate investors, investment groups, or private lending companies. These private investors are often looking for a higher return on their investment than traditional banking products can offer, and they are willing to accept the higher risk associated with these loans.

Qualification Requirements for a Hard Money Loan

The qualification requirements for a hard money loan vary depending on the lender. However, these are the general requirements you can expect:

Qualification CriteriaDescription
Property TypeThe loan is usually secured against a property. Common types include commercial properties, investment properties, and residential properties for flipping.
Property Value and EquityThe value of the property being used as collateral is crucial. Most hard money lenders require significant equity in the property, often at least 25-30%.
Loan-to-Value (LTV) RatioLenders typically offer a loan amount based on a percentage of the property’s value (usually 60-75% LTV).
Exit StrategyBorrowers must present a clear and feasible exit strategy for repaying the loan, such as selling the property or refinancing with a traditional loan.
Borrower ExperienceExperience in flipping or managing properties can be beneficial and sometimes required.
Financial StrengthWhile less emphasis is placed on credit scores and income compared to traditional installment loans, borrowers still need to demonstrate some financial stability.
Down PaymentA larger down payment may be required, especially if the LTV ratio is high or if the borrower’s financial situation is less stable.
DocumentationBasic documentation may include proof of identity, a description of the property, and a plan for the property. More detailed financial information might also be requested.

Real estate attorneys, traditional mortgage brokers, and financial advisors can assist with the application process for hard money loans. These professionals can help navigate the complexities of the loan agreement, ensure compliance with regulations, and negotiate terms on behalf of the borrower. Many online resources and financial blogs also provide valuable insights into hard money lending.

Pros and Cons of Hard Money Loans

Learning about the pros and cons of hard money loans can help you assess how much the advantages will help you out compared to how much the disadvantages could hurt your budget. 

Pros

Speedy Approval and Less Strict Underwriting

Hard money loans can have significantly faster approval times compared to other types of real-estate secured funding. Approved borrowers could access cash from hard money loans in a matter of days to start receiving cash flow more quickly. This streamlined service can also cause hard money loans to have less underwriting charges than traditional mortgages.

Approval Based on Collateral 

Since a reputable hard money lender offers secured loans, they usually care more about the equity in a borrower’s collateral instead of their FICO score. So, bad credit borrowers may be able to access high loan amounts via hard money loans if they own property with enough equity.

Ability To Fix and Flip Properties

Home renovations can get expensive and wreak havoc on one’s personal finances, making it difficult for real estate investors to fix up properties and resell them without an alternative source of income. Hard money loans can make it more convenient for people to perform repairs and renovations to civilian or commercial properties and then go on to sell them to individuals or businesses.

Cons

High Rates and Short Repayment Terms

Hard money loans are known for having exceedingly high rates and brief repayment terms. High rates paired with short repayment terms typically result in high loan payments, which may be difficult for some borrowers to keep up with. Furthermore, since hard money loans are secured, borrowers risk having their property repossessed from default.  

Large Down Payments Are Often Required

Hard money loans may also require a down payment based on the loan-to-value (LTV) ratio. A loan-to-value ratio is simply the funding amount of a loan compared to the value of the collateral used to secure the funding. Instead of offering loan amounts based on 100% of the value of a property, a hard money lender may fund loans for approximately 70% to 80% of a property’s equity. 

Since the down payment for a hard money loan is usually calculated using the loan’s LTV, loans secured by properties with high equity will almost always require a high down payment. If you cannot afford a large down payment at the beginning of your loan period, you may not be able to qualify for hard money loans.  

High Risk

Borrowers who take out hard money loans risk the housing market declining and significantly lowering the value of their property. A significant drop in the housing market may cause the value of a borrower’s property to decrease to a value that is lower than what they currently owe on their hard money loan. Situations like this result in what is called an upside-down loan. 

A loan is usually considered an upside down loan when the collateral used to secure the funding is worth less than the balance due on the loan. The difference between an auto loan and home equity loan is the type of collateral used. But similarly to hard money loans, that may become “upside down” if their market value drops drastically. 

May Require “Track Record” of Successful Loans

While hard money loans are usually considered high risk for the borrower, they may also be considered high risk for the lender as well. To counter risk, some hard money lenders tend to favor borrowers with a track record, or proven history, of successfully paying off hard money loans. 

Who Should Not Get a Hard Money Loan?

There are instances when it’s better for consumers to work with traditional lenders. For example, the following individuals may be better off with a traditional loan than a hard money loan:

  • Borrowers without a clear exit strategy for the property
  • Borrowers unfamiliar with real estate investing
  • Anyone who might struggle with the higher rates and shorter repayment terms

Alternative Financing Options to a Hard Money Loan

Before contacting hard money lenders, consider the following options that may be able to offer you a better deal: 

  • Traditional Mortgages — A traditional mortgage may take longer to fund, but there’s a better chance your traditional loan will be backed by a bank, offering you security that hard money loans can’t. 
  • Home Equity Loan or HELOC — If you own a home or property, you may use the equity in it to get a home equity loan or home equity line of credit (HELOC). Similar to a hard money loan, you could get a guaranteed home equity loan with bad credit. However, home equity loans and lines of credit may have more manageable rates.  
  • Personal Loan — A personal loan may be a better alternative to a hard money loan. While personal installment loans are usually unsecured, they may be able to provide borrowers with flexible terms, competitive rates, and loan amounts ranging from a few hundred to a few thousand dollars. 

FAQs About Hard Money Loans

How are hard money loans different from traditional loans offered by banks?

Hard money loans, typically offered by private investors or specialized firms, are secured by property and have shorter terms and higher interest rates compared to traditional installment loans. They are often quicker to obtain but come with higher risks and costs. Consider what is best for your personal finance needs. 

Are there restrictions on the types of properties I can purchase with a hard money loan?

Most hard money lenders are flexible but generally focus on commercial properties, investment properties, and sometimes residential properties for flipping. They usually don’t offer hard money loans for primary residences due to regulatory restrictions.

Where can I find and apply for hard money loans?

You can find hard money lenders through online directories, real estate investor networks, or personal finance forums. Applying typically involves presenting your property details, your financial plan, and your exit strategy.

What kind of interest rates and terms can I expect from a hard money loan?

Interest rates for hard money loans are generally higher than those from traditional lenders, often ranging from 8% to 15%. The terms are shorter, usually 1 to 3 years, making them suitable for short-term financing needs.

Who regulates hard money lenders and ensures fair practices?

Hard money loans are regulated at both the state and federal levels, but the specific regulations can vary significantly. They are less regulated than traditional loans, but lenders are still required to comply with state usury laws and federal regulations like the Truth in Lending Act (TILA) and the Real Estate Settlement Procedures Act (RESPA). It’s important to conduct thorough research and possibly consult a legal advisor to understand the terms and legal implications.

What are some alternatives to hard money loans for financing property investments?

Alternatives include traditional bank loans, home equity lines of credit, and personal loans. These options might offer more favorable terms, especially in terms of interest rates and repayment periods, compared to hard money loans.

What should I consider before deciding on a hard money loan?

Consider the higher interest rates, shorter repayment terms, and the risk of losing your property if you default. Hard money loans are best suited for experienced investors with a clear strategy for the property and a solid exit plan.

The Bottom Line on Hard Money Loans From CreditNinja 

Now that you know the hard money loan definition, you can decide if you want to apply for one. A traditional mortgage usually has a long approval process and strict qualification requirements. In contrast, a homeowner could get a hard money loan quickly despite bad credit. The best choice for you depends on your financial situation and overall budget. But remember that there are alternative options available, such as personal loans. 

At CreditNinja, we believe everyone should have access to financial information. That’s why we offer articles on almost every personal finance topic. Check out the CreditNinja Dojo to learn the 5cs of credit, how to qualify for a bridge loan, how to improve a credit rating, and more!

References:

  1. How Many Homeowners Are There In The U.S.? │ Simply Insurance 
  2. Average Hard Money Loan Rates │ All Around Moving 
  3. Non-Conforming Loan │ CFI
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